Sept. 28, 2010

For both members and credit unions, auto financing is a huge issue.

According to Bill Myers, a person who has a car has more job options and generally makes 25 percent more than someone who doesn’t have a car. Having a vehicle also helps with family extracurrciulars.

“Owning a car is fairly significant with the way society is structured,” said Myers, CUDE, REAL Solutions field coach and senior fellow with the Aspen Institute, during a REAL Solutions Webinar.

According to data cited by Myers, 12 percent of credit union assets are car loans. While CUs’ piece of the overall car loan pie is about 20 percent, they have a much smaller share of the non-prime auto loan market where payday and other non-traditional lenders are key players.

If credit unions could successfully serve a greater portion of the subprime auto lending market, they would both help members avoid working with payday lenders and make contributions to the credit unions’ own bottom line.

In his “Steer Clear” Webinar, the first in a series, Myers outlined seven lessons in successful non-prime auto lending, based on a REAL Solutions’ report by the same name. Individual lessons were expanded upon in follow-up Webinars, now available in playback form.

Lesson 1: Non-prime auto lending is a financially viable line of business.

Myers cited information from a 2006 report of University Federal Credit Union, Austin, Texas, that described how the CU stopped doing indirect lending cold turkey, in favor of risk-based lending to all credit levels.

According to data from the CU’s report, it charged 17 percent on car loans for E credit members (compared to 6 percent on loans to A+ credit members). These loans had a loss rate of almost 5 percent, plus larger origination costs and maintenance costs than loans to people with A, B, C or D paper.

“They did something brave in my mind,” Myers said. “They went cold turkey on indirect lending, saying ‘We’re getting car loans of poorer quality and we can’t really figure out a way to get that indirect member to be a full member of the credit union.’ So they now do risk-based lending.”

The CU has “extensive loans with high losses, but they’re making a heck of a lot more (spread of 7.92 percent) than with A+ paper (spread of 2.68 percent),” Myers said. “This credit union has done a great job of demonstrating to their board and themselves, this is really great business for us.

“We have to realize that we have to price our loans for risk and effort,” he emphasized. “We can still receive a contribution to net income and give our members a much better deal than what they have right now.”

Lesson 2: Using more data drives more approvals.

In looking at the underwriting strategies of 866 credit unions working with REAL Solutions, Myers and his colleagues found that CUs have a huge turndown rate on loans.

“It’s not uniform; some are lower,” he said, “but some credit unions have turndown rates on loans of up to 85 percent. On average, 50 percent of CU loan applicants are turned down.

“If half of the people looking for a loan with their credit union turn away thinking they’ve misunderstood what your credit union is, we lose members out of that and do negative branding for ourselves.

“If we could figure out how to evaluate these loans differently, if we could figure out how to approve loans with FICO lower than 600 or no FICO, we could expand our marketplace.”

Myers suggested looking at Fair Isaac’s Expansion score, which takes a deeper look at the creditworthiness of non-prime borrowers. When data is added into traditional scoring to develop the Expansion score, a large group of people become possible borrowers.

“There is an excellent opportunity to book credit-worthy applicants within the underserved market,” Myers said.

While some non-prime members are “scorable,” others are not. In the case of an unscorable member, considering other kinds of data in the loan decision may help your CU be able to say yes, he added. This data might include payment of monthly rents/leases/utility bills, electronic bill payments, Internet and catalog purchases, public information such as tax liens, and internal credit (how your member pays you as opposed to any other financial institution).

Myers emphasized that it’s important to combine Lesson 2: Using more data gets you more approvals with Lesson 7: Keep in touch with borrowers by monitoring and collecting loans early. (see below)

Lesson 3. Assist members in finding cars.

All too often credit unions find that indirect financing falls apart at the dealership, Myers said. After encouraging members to stop at the credit union first, get a loan, and obtain a check that they can sign over at the time of purchase, sometimes dealers still lead members to give up their good credit union deal in favor of dealer financing that’s less favorable to the member.

Myers suggested taking control of the process by becoming an advocate in finding a car for the person. In particular, Myer cited AssetPlatform.org (a REAL Solutions project), which helps members find cars and also steers them toward credit union financing.

Lesson 4: An in-person close cements bonds with members.

Closing the loan in person makes a huge difference in how the loan gets paid, Myer said. Closing in person allows the credit union to better:

• Thank the member for the business.
• Verify loan application info.
• Review all loan terms.
• Keep in touch.
• Cross-sell other credit union products.
• Provide a guaranteed refinance offer.

Lesson 5: Insure borrowers against events out of their control.

Myers discussed Walkaway insurance. If purchased for an auto loan, this insurance pays off the car if the member gives the car back to the lender, and the member experiences no further collection or credit degradation.

“It’s a wonderful concept,” Myers asserted, noting that Walkaway consists of several products, depending on the state, including collision, mechanical breakdown or extended warranty, loan deficiency, debt cancellation for divorce/injury/loss of job, and credit life.

Lesson 6: Export risks by using loan-loss insurance products.

Lender’s insurance, essentially buying into a risk pool, can protect the credit union, Myers said. “A little bit of the interest rate goes to an insurance company. It’s an interesting way to get into higher-risk loans. It’s a good thing to take to the board.”

After using such insurance for six months to a year, credit unions tend to take one of two paths, Myers said. The first path is to note that claims are less than what the CU is paying in premiums. These CUs say, “The margin is there and I’ll take the risk myself. I’ll have a bumpy loan-loss reserve, but I’ll make more money in the year.”

The second path notes that with the insurance the CU’s loan-loss reserve number stays the same. These CUs say, “Let’s put all the loans through this process, even A+ loans for which the premium is much lower.”

Lesson 7: Allocate resources to collect the loan quickly.

Many credit unions in the REAL Solutions group contact non-prime borrowers when they’re just one day late, Myers said. “That may seem quick, but payday lenders contact borrowers one day before the payment is due. Repossess when the borrower is 30 days late.”

Lisa Hochgraf is a CUES editor.